Italy: Reforms Needed For Stronger Growth and Stability

July 27, 2017

Italy has started to grow again in recent years. But the recovery has been too weak to help claw back the ground lost from subpar growth that started well before, and was exacerbated by, the global financial crisis. In its latest economic health check of Italy, the IMF suggests a package of measures that simultaneously supports growth and reduces debt.

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Average Italians still earn less than two decades ago. Their take-home pay took a dip during the crisis and has still not yet caught up with the growth in key euro area countries. On current projections, it could take nearly a decade for wages to return to their 2007 levels—during a period when euro area partners are expected to pull even further ahead in Europe’s multi-speed economy.

The young and the working age population are hardest hit

The growth slowdown and the burden of the crisis have fallen disproportionately on the working age population and younger generations. Unemployment, including among the young, is very high, while in general and taking into account price changes, the incomes and wealth of the working age population have declined below 1995 levels. That is in contrast to those of older households and pensioners.

Against this backdrop, a key question for policymakers is how to enhance incomes and productivity, while at the same time protecting the poorest and lowering long-standing vulnerabilities such as high government debt. Decisively lifting incomes, creating jobs, and reducing government debt will require more effort and broad-based, sustained political support for reforms, the IMF observes.

A better way to bargain

One area to improve is wage bargaining. Over the past two decades, wages have generally grown faster than the output produced per worker. In fact, it is in Italy that the cost of producing a unit of output in manufacturing has increased the most in comparison to key euro area peers such as Germany, France, and Spain. More expensive production in Italy compared to its peers has adversely affected job creation, investment, and production.

IMF research shows that by aligning wages with output produced per worker at the firm level instead of national level would result in an almost 4 percent increase in the number of people employed.

While such an improvement in wage bargaining by itself would already result in growing exports, investment, jobs, and output, its impact could be magnified through a series of government measures. The state should

· improve competition in product and service markets (for example, professional services, retail, and local public services);

· accelerate the cleanup of bank balance sheets; and

· enhance the effectiveness of the public sector and civil justice system.

In the decade before the global financial crisis, Italy’s spending grew faster than its income, in important part because of increases in pensions. Since the crisis, the government has succeeded in containing spending, mainly by freezing wages and hiring in the public sector, and by cutting public investment.

However, it has not been able to reverse the pre-crisis spending excesses. The tax burden is heavy, about three-fourths of which is directed toward wages, pensions, and health spending, as well as interest on public debt. This leaves too little for public investment and for the protection of the most vulnerable. The quality of services remains relatively poor. At the same time, public debt is very high and, despite recent efforts, Italy has not started to reduce it.

Support growth, reduce debt

A better mix could support growth and shield the most vulnerable, while putting debt on a firm downward path. With a package of high-quality measures on the spending and revenue side the country could balance the need to support growth on the one hand with the imperative of reducing debt on the other. Such a package includes

· more public investment;

· better targeting resources to the most vulnerable;

· lower pension spending that is the second highest in the euro area; and

· lower tax rates on labor, and bringing more enterprises and persons into the tax net.

Decisive implementation of such a package, together with reforms of wage bargaining and others outlined above, can raise Italian incomes by over 10 percent, create jobs, improve competitiveness, and substantially lower public debt in the next decade, IMF research finds.